Why prepaid cards aren’t for everyone

Be wary of fees and know what you need before choosing

CHICAGO (MarketWatch)—The furious growth of prepaid cards might make you think you’re missing something. But the wide range of fees and features can limit these cards’ use and, in some cases, make them downright wrong for some consumers.

“They may be rising in popularity because of a lot of false assumptions about them,” said Odysseas Papadimitriou, chief executive of CardHub.com which recently released a study of the prepaid industry. “A lot of these cards are great for one purpose but completely useless for another purpose.”

J.P. Morgan Chase’s Chase Liquid reloadable card.

Some cards allow you to directly deposit money without charge while others accept only cash and slap a fee on loading. You can pay online bills on some but not others. Some have monthly fees while others charge inactivity fees if you don’t use the card for extended periods.

“Most people don’t realize there are a lot of fees in the fine print,” said Beverly Harzog, an independent credit-card expert and consumer advocate. “You’re basically spending money to use your own money.”

Prepaid cards are the only banking product to explode in growth in recent years, making them the go-to source of new revenue for card issuers. J.P. Morgan Chase, for example, introduced the Chase Liquid reloadable card in May, following prepaid-card launches by American Express, Capital One, SunTrust and Bank of America, among others.

In 2011 alone, some 13% of all Americans used prepaid cards, versus barely a blip on the radar screen before 2008. That was up from an 11% jump the year before, according to market researchers Javelin Strategy and Research.

At the same time, consumers miffed by higher banking fees or snubbed by the banks gave up their traditional checking and savings accounts and credit and debit cards at the same 11% rate, Javelin reported.

Another study noted that the total dollar value of funds loaded onto prepaid cards is growing at an annual 42% clip. In 2011, a Mercator Report said $57.2 billion was loaded on prepaid cards, up from $19.5 billion in 2008.

That kind of growth is prompting the Consumer Financial Protection Bureau to consider new rules for general-purpose reloadable cards.

How they work

Prepaid cards look and act much like debit and credit cards. But unlike credit cards, there are no funds advanced. You must preload the card with cash before you can use it and generally aren’t allowed to “charge” on them once the cash has been spent.

Also, unlike federal guarantees on money in the bank, most prepaid cards are not regulated and are largely self-policed. Only a few cards offer the same FDIC insurance afforded to checking- and savings-account customers. The Chase Liquid, for example, which carries a monthly fee of $4.95 and allows users to access some of the same services traditional checking-account holders use, is covered by the Federal Deposit Insurance Corp. should the bank go under.

Prepaid cards have proven useful for those who are unbanked or underbanked because they allow them to live effortlessly in a credit-focused society that requires plastic to buy airline tickets, rent autos and get through toll booths easily. Increasingly, consumers look to them as an alternative to a traditional checking account.

But at a time when consumers are angry about fees to use their own money, prepaid cards may be a bigger culprit than the traditional checking account.

The AccountNow Visa pay-as-you-go card, for example, can cost far more than a $7 monthly fee on a checking account. Though there is no monthly fee, it will cost you $4.95 to activate the card and $1 per transaction, whether you sign or use a personal identification number. ATM withdrawals are $2.50 a pop at in-network machines with added surcharges out of network. Reload fees are free except at retail locations where it will cost you $4.95 each. Customer-service fees will set you back another $1 per live call or 50 cents for automated account information. Cancellation and inactivity fees stand at $15.95.

If you use the card on 20 transactions a month and make four ATM withdrawals at $2.50 each that rings up to $30, according to a CardHub study of 20 prepaid cards—and that’s without customer service. Read the report.

The American Express prepaid card boasts no activation fee, no monthly fee, no reload fees with direct deposit or bank and account-to-account transfers, and no customer-service or cancellation fees. One ATM withdrawal per month is free, and $2 for each extra. Reload fees from a retail location are $4.95.

That looks like a great card for a customer who reloads with a direct deposit and doesn’t overuse the ATM. But it isn’t a suitable checking alternative if you want online bill pay or want to reload with a check, neither of which are allowed.

If you use that card on 20 transactions a month and make four ATM withdrawals, it will cost you $6.

But there are plenty of banks and credit unions that offer free checking accounts and will take the money in any form. For example, TCF Bank recently did away with its checking-account fees and requirements.

“Fees drove a lot of people out of banks,” said Bill Cooper, chief executive of TCF Bank. “We saw new-account levels go down and higher attrition as consumers went to cash and prepaid cards.

“Now we’re back to where we started,” he said, noting that TCF was a pioneer among regional banks to drop checking-account fees in 1986 as a way to compete with the big banks’ high-fee structures.

Card confusion

Here’s what else is proving confusing to consumers: Prepaid cards that are situated next to gift cards at grocery and other retails stores.

“People think that they can give them to people for presents,” Papadimitriou said. “But they get really shocked when they’re asked for their Social Security number to verify you are who you say you are before you get a permanent card.

“When you give someone a prepaid card, you’re giving them a bunch of fees,” he added.

You have to give up that personal information because the federal government wants to make sure you’re not a bad guy trying to launder drug or terrorist money by unloading $10,000 here, $5,000 there of what essentially is cash to anonymous benefactors. Because it’s a prepaid card, criminals can use that money overseas to withdraw money for nefarious acts.

Harzog said she considers prepaid cards “a temporary solution” for those who can’t get into the banking system because they don’t have enough credit or have destroyed their credit.

“Consumers should keep working to get back in the mainstream financial system,” she said. Prepaid cards don't help build your credit, despite a number of claims that they do. The credit bureaus don’t care how you use them as they are not bothered with how you spend cash.

But consumers who can’t escape using prepaid cards, Harzog said, should do their own cost-benefit analysis to determine what card best matches their needs at the lowest cost.

“It’s almost impossible to not have any fees unless you’re very careful and you understand the fee structure for the card you’ve chosen,” she said.

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